In our recent study Perceptions and Understanding of Money — 2020, we surveyed Americans to gauge how well they understand the mechanisms of money, including phenomena such as inflation. We hope that this “Everything You Need to Know” series will help improve understanding of money-related topics and issues which could not be more relevant today.

 

What is inflation?

 “Inflation” refers to a straightforward measure: how quickly the price of goods and services increases in a given economy over a specific period of time, per Investopedia. If the cost of a mango at your local grocery store was 20 cents in the year 2000, and is 80 cents today at the same grocery store, then you’re witnessing inflation.

 

The Balance explains that inflation rates for specific goods and services may be different, but may generally rise or fall together given enough time. Though the cost of an iPhone may steadily rise over a significant period, the price of gas can fall during that same period. Ultimately, however, both goods will cost significantly more in 50 years, just as a car or home was substantially less expensive 50 years ago (in dollar-for-dollar sense).

 

The quicker the cost of goods and services rise, the less your dollar can purchase—this, in a nutshell, is inflation. When prices rise at a rate of 50% or more in a month, then hyperinflation has set in, which generally reduces the value of a currency to the point where it has little to no purchasing power except in astronomical amounts.

 

One must understand the causes of inflation to fully grasp the concept of hyperinflation.

 

What causes inflation?

 Inflation-causing behaviors taken to an extreme generally produce extreme inflation—in other words, hyperinflation.

 At its core, inflation is the result of expanding a money supply. One measure of money’s value is scarcity. When the U.S. dollar was backed by gold, scarcity was virtually guaranteed. Because paper dollars and coins were legally redeemable for gold, the amount of money in circulation was tied to the amount of gold in reserves. Those tasked with redeeming dollars for gold when requested—ostensibly the U.S. government—could not print more money than they would be able to redeem for gold at any given time.

 

Once a currency is decoupled from a scarce medium of exchange such as gold (America began its rejection of the Gold Standard in 1933, per HISTORY) then a government is free to print money as it pleases. 

Have mounting national debts? Print more money.

Need to bail out banks who blew a fortune lending customer deposits to high-risk borrowers? Print more money, then “lend” it to those banks.

Members of Congress deserve a pay raise? You know what to do: print more money.

 

Ultimately, the ever-expanding money supply means a constant decline in a currency’s scarcity, which lessens the value (i.e. purchasing power) of your dollars. This is how inflation happens. Take this expansion of the money supply to the extreme and you have hyperinflation.

 

Piles of German money in a Berlin bank during the post-World War I hyper-inflation. In 1923 an American dollar was worth 800 million German marks.

Piles of German money in a Berlin bank during the post-World War I hyper-inflation. In 1923 an American dollar was worth 800 million German marks.

 

What are the pros of inflation?

 The Federal Reserve notes that the ideal rate of inflation is 2%, or just below that mark. The stated benefits of moderate inflation are to promote economic growth and stave off deflation. The general idea is that deflation is a fate worse than inflation, as it could lead to lower prices, businesses contracting, and the economy moving backwards.

 

By the Fed’s thinking, inflation should produce higher wages (to keep pace with rising prices), though this may not always be the case. Another pro: as each individual dollar becomes less valuable due to inflation, the real cost of your debt decreases. That dollar in debt that you owe is now worth only 50 cents, the theory goes.

 

Yet, these supposed benefits are often outweighed by the downsides that occur when extreme inflation takes hold.

 

What are the cons of inflation?

 A column published in Forbes touches on the downsides of inflation, as the author wonders openly whether America could be in for a period of hyperinflation itself. Consider the indicators correlated with extreme inflation, and whether these are characteristics of 2020 America. They include:

  • A stressed government budget (The United States’ national debt is beyond $26 trillion and increasing rapidly by the second)
  • Sociopolitical upheaval (no elaboration is necessary)
  • A “collapse” of the supply of goods (McKinsey notes that the food supply is among the victims of the pandemic)
  • A decline in borrowing and lending (Quartz reported earlier this year a notable decline in business loans)

 

The signs for extreme inflation are there, and some argue that it is only a matter of time before Americans feel the pain in their wallet directly, even more so than they already have.

 

The downsides of extreme inflation become abundantly clear to those who live it, and generally include:

  • A higher cost of goods, often without a corresponding increase in wages to match rising prices
  • Less investment and lending amidst massive economic uncertainty
  • Less production of goods and services due to less business investment, which further increases prices because of scarcity of in-demand products and services
  • Loss of savings because the value of each dollar saved decreases drastically
  • Hoarding of goods and assets with tangible value, which further restricts supplies (think: toilet paper and ammunition in the early days of the pandemic)
  • Job losses as the effect of lesser investment leads to contraction among individual businesses

 

Because the U.S. dollar plays a central role in the global economy, hyperinflation in America could spark a chain reaction of global financial uncertainty.

 

Is Crypto an alternative in times of inflation?

 Some see cryptocurrency as an answer to the volatility of unbacked, non-scarce paper currency. Cryptocurrency is scarce by design, meaning that it is not subject to the dilution caused by expanding the supply of money supply—that is, cryptocurrency is not subject to inflation as we understand it.

 

For this reason, many are turning to cryptocurrency as a hedge against increasingly volatile fiat currencies including the U.S. dollar.

 

Interested? Start mining cryptocurrencies with us. Read this if you want to understand Why Mining makes sense.





Source link

Register at Binance